At the end of last week Tesla announced that it would build its first factory outside the US in Shanghai. And given Tesla’s cash flow situation, Tesla must finance this factory’s development with external funding. However, the window for making such a funding request from bond- or shareholders may be very narrow.
The tech bubble is in its last throes
How much longer can scooter rental companies raise $150 million on the back of speculative $1 billion market valuations? That’s the question I asked last month. And to get to the answer, the headline I chose to use was all about Tesla because, more than any other company, Tesla represents the field of dreams ethos of this tech boom.
Now, Tesla understands that time is short. That’s why it announced a restructuring in June. The market loved it. And shares went up almost 10% in the four trading days following the announcement.
But that was the high point. Since then, Tesla shares have slumped from $370 to less than $320. That’s over $20 lower than where Tesla shares traded on June 12th when it made the restructuring announcement. So clearly, Tesla has some work to do to convince investors that its market valuation is sustainable.
Tesla needs money
So it’s surprising that Tesla made a major announcement last week about expanding in Asia. Now, this move was announced as Tesla raised the price of its US-made vehicles by 20% in China. That’s because of tariffs due to the US-China trade war. So ostensibly, the production facility in China is a way of circumventing those tariffs and offers a rebuke to US President Trump about his trade tactics.
Nevertheless, I am sceptical. After all, negotiation for this factory has been in the pipeline for months.
Back in February, Bloomberg reported those negotiations had stalled due to a disagreement about ownership. China’s central government demanded the plant be a joint venture, which would risk corporate espionage and technological theft, a big issue in the trade war between the US and China. Apparently, the factory is slated to go ahead as a Tesla-owned and operated facility. And that represents a significant concession by the Chinese. Likely politics played into the decision.
The reality is that Tesla needs money. That’s irrespective of whether they build this new facility. But the fact that this facility is so large does allow Tesla to raise quite a bit of cash under the guise of expansion.
How many cars can Tesla produce?
Take a look at the numbers for a second. Here’s Reuters:
Tesla plans to produce the first cars about two years after construction begins on its Shanghai factory, ramping up to as many as 500,000 vehicles a year about two to three years later, the company said.
That would make Tesla’s Shanghai plant large by auto industry standards, where most factories are tooled to build 200,000 to 300,000 vehicles a year, and roughly equivalent to the planned annual production at Tesla’s plant in Fremont, California.
Tesla shares rose 1.5 percent in U.S. trading even as some analysts questioned where the money-losing company will get the capital required to build and staff such a large plant.
Musk has said Tesla will be cash-flow positive this year. Analysts have predicted it will raise capital to fund a list of new projects, including launching an electric semi truck, a pickup truck, a compact SUV and new battery and vehicle production facilities that Musk has proposed for China and Europe.
“I am sure that Tesla needs fresh money at the latest next year,” said Frank Schwope, an analyst with NORD/LB.
The Shanghai government suggested it could help with some of the capital costs. “The Shanghai municipal government will fully support the construction of the Tesla factory,” its statement said.
500,000 units per year!!
Tesla is only producing 5,000 units in America a month right now. Tesla just announced that it was slashing delivery times for the Model 3 because of accelerated production. But it’s not going to ramp from a 60,000 car annual run rate to 500,000 out of a new factory in China alone. That’s pure fantasy.
So clearly, these are ambitious future targets with tons of excess capacity built in.
And Tesla wants to raise billions of dollars on the back of this.
Where will the money go?
Now if Tesla raises capital in the equity markets, it can pretty much do whatever it wants with that money. On the other hand, if it raises money with debt, sometimes the debentures stipulate in covenants how the money can be used. But covenant-lite debentures have become standard now. And I reckon Tesla could say that it wants the money for Shanghai and simply use the money for whatever purposes it sees fit.
This would be advantageous if capital markets shut, given Tesla’s cash flow drain.
My suspicion here is that Tesla is doing this Shanghai deal in part as cover to go back to market to raise capital, knowing that it can use that capital for its cash-bleeding current operations. Only later will the Shanghai plant production need capital, if it ever gets built.
Tesla is fraught with risk
Tesla is a completely speculative, junk-rated venture. Investors in the company are betting on Elon Musk’s celebrity as a forward-thinker, hoping he can ramp up production and achieve significant economies of scale. At present price levels, though, that’s an unfavourable risk/reward for shareholders. Even bondholders face significant default risk should the economy turn. Hence the junk rating for Tesla’s debentures.
Tesla’s 5.3% notes due in 2025 are trading at 88 cents on the dollar. That’s near the all-time lows from late-May. It’s a loss of over 10% since the bonds were first issued in August 2017. So clearly bond investors are seeing risk, particularly given Elon Musk’s erratic behavior of late.
Just yesterday, Musk went on a Twitter rant, calling a British diver who aided the Thai cave rescue a “pedo” without any evidence whatsoever. That’s nuts frankly. Are investors going to double down and hand Musk more money? And if they don’t, what then?
If the global economy slows sharply in the next 12-24 months and enters recession, as I believe likely, Tesla shares are going to zero. There is no way the company can survive a global recession with its cash burn rate and dependence on wealthy customers who will be hit the hardest when asset prices fall in the next downturn.